It's been a few years into the economic recovery from the Great Recession, and the employment picture has been rocky. Rather than a quick bounce back with strong employment and higher wages, this recovery has seen the unemployment rate trickle down to its current 5.4%. Meanwhile, the wages for the majority of workers have been stagnant, especially when considering the level of wages adjusted for inflation, or the real wage.

The Real Wage

Income is earned by workers in order to pay their bills, support their families, and buy stuff that people need and want. In other words, it is the buying power of that income that is important. If a worker earns a nominal wage of $100,000 a year, but the prices of all goods and services are high, the buying power of that income is effectively lower than a hypothetical second worker earning a nominal wage of $50,000 who is able to buy all goods and services for less than half the cost of the first worker.

Inflation is when the general price level of all goods and services is increasing: when stuff is becoming more expensive. If the rate of inflation exceeds the rate of nominal wage growth, then the real wage falls. Take for example a situation where wages are growing nominally at 1.5% per year, but inflation is increasing at 2% per year. The net effect is a 0.5% decline in the real wage since the buying power of the money earned has been reduced. (See also: Why is Deflation Bad for an Economy?)

In the United States, the rate of inflation is typically measured using the consumer price index, or CPI. This index compares what it costs to buy the same basket of goods and services over time. If the cost of that collection of goods and services increases, then the economy has experienced inflation. (See also: Why the Consumer Price Index is Controversial.)

The graph below shows the level of real wages over the past ten years for full time workers in the United States. It is striking to see that since 2010, the real wage has fallen and stagnated through the present. During the Great Recession, inflation dropped to very low levels and the central bank even became worried about a possible scenario of deflation, or a general decrease in the prices of goods and services throughout the economy. A sudden drop in the inflation rate explains the relative increase in the real wage in the period from 2009 - 2010. 

But over the long run, the real wage is not governed entirely by the rate of inflation, for if it were, central banks could achieve higher wages simply by lowering their inflation targets. Rather, real wages are influenced primarily by real underlying economic fundamentals, such as productivity, GDP growth and labor's bargaining power. In fact, for moderate levels of inflation, there is no empirical relationship between changes in the CPI and the rate of long term GDP growth. (For more, see: The Importance of Inflation and GDP Growth.)

 

Real Wages Have Stagnated

Even the low inflation following 2008 has not been enough to stimulate consistent growth of the real wage. One reason is that following the economic crisis, the unemployment rate rose to near historic high levels, with many remaining unemployed for extended periods of time. In this situation, people looking for work begin to accept lower and lower wages in order to return to work and provide for themselves and their families. At the same time, employers are apt to cut back on pay raises and bonuses knowing that their current employees will not be so eager to quit in a labor environment where they might not be able to find the same work readily and may end up having to work for less. Companies do not usually act in this way because they are exploiting workers, rather companies seek to cut costs wherever they can in order to keep the business afloat during a recession, and labor is usually quite a large cost. 

Even with the headline unemployment rate falling to pre-recession lows, the number of under-employed (those working part time because they can't find full time work or working multiple jobs to make ends meet) is still high. This pool of underemployed workers keeps a downward pressure on the real wage as they are more likely to accept better employment for at a reduced rate. (For more, see: The Unemployment Rate: Get Real.)

High and persistent unemployment helped keep the real wage depressed, but even through the recovery as GDP growth increased, the real wage has remained more or less the same. Another culprit is technology. The recovery has seen a dramatic rise in worker productivity while those more productive workers are not being compensated for the increase in output.

Technological progress, especially progress in computing, the internet, mobile devices, and software, has changed the jobs landscape. If technology can do the same job as a person but cost less, the technology will win out in a competitive marketplace where being the low cost producer is rewarded. Take for example the recent push by fast food workers to raise their minimum wage to $15 an hour. While on the surface, this seems like a logical step in promoting income equality and raising the standard of living for these workers, the unintended consequence was that fast food corporations began implementing trial runs of automated kiosk systems to replace a large number of human workers. The decision to deploy such software systems on a large scale will ultimately come down to which is more cost effective: the wage of an employee or the amortized cost of the technology solution. Unless a worker is willing to accept a wage lower than the cost of technology, they will eventually be replaced. (For more, see: Is Automation Destroying Intellectual Jobs?)

Will Real Wages Rise in 2015 and Beyond?

The question now becomes, will the real wage finally start to rise. A recent study by Duke University which surveyed the nation's chief financial officers (CFOs) indicates that the real wage may finally be growing, with nominal wages growing 3.3% over the next 12 months, and hiring expected to rise by 2.4%. If inflation keeps growing at a snail's pace (currently growing at around 1.5% annually), then the real wage growth will mean greater prosperity for the American worker. With a higher real wage, workers will be able to buy more, which may lead to continued economic growth. The increase in hiring indicates that the unemployment rate will remain low, which could increase the bargaining power of workers and allow them to finally demand pay raises and higher minimum wages.

If these positive forces can outpace the downward pressures of underemployment and technological change, then the real wage could indeed finally begin to rise this year. One danger from such a rise in the real wage is so-called wage-push inflation, where increased wages trickle down through the economy and actually increase the rate of inflation making everything more expensive, and reducing the real wage again, a sort of catch-22. This happens as employers are forced to pay more for labor; in order to remain profitable they end up raising the prices of their products, causing a chain reaction to the detriment of workers.

The Bottom Line

Real wages have stagnated since the Great Recession, and only now are those inflation-adjusted incomes starting to rise for the average worker. High levels of unemployment and underemployment played a major role in keeping wages flat, but the unemployment rate has been steadily decreasing and hiring seems strong today. As employment strengthens and wages are forced upwards, the specter of wage-push inflation still remains which can cancel out some of those positive effects. Technological change which can replace both low-skill and, increasingly, higher-skilled jobs will also be a persistent downward pressure on wages as companies, who seek to cut costs, find that the technology solution is a cheaper alternative to the human worker.

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